Alex Brazier (pictured), financial stability strategy and risk executive director at the BoE, said corporate bonds held in open-ended funds in the UK and euro area has increased 70% since the global financial crisis, while market makers are retreating from the asset class.
Speaking at a London Business School conference on the asset management industry, Brazier said the central bank is testing the corporate bond fund market for its resilience in periods of market stress, but noted simulations are still in the development stage.
It first published concerns about the issue last July in light of open-ended property funds that were gated post Brexit on the back of large redemptions.
Less market marking activity could exacerbate a liquidity mismatch in corporate bond funds in a period of mass redemptions, he told the conference.
“Our analysis suggests that, in response to asset sales by high-yield bond funds, the extent to which dealers are willing to see their inventories of corporate bonds increase has shrunk by a factor of about seven,” he said.
While Brazier acknowledged swing pricing, dilution levies, gates and suspensions can mitigate bond liquidity issues, he said the Bank still wanted to investigate first redeemer advantage in corporate bond funds.
Redemptions from corporate bond funds are seven times more sensitive to price moves than equity funds and twice as sensitive as in sovereign bond funds, he said.
Corporate bond investors receive the net asset value of the fund on redemption, but on large redemptions the fund manager may not obtain this price when they sell the underlying securities, Brazier said.
He said: “Without other measures, redemptions from funds invested in less liquid assets can transfer economic value from remaining to redeeming investors. That could create an incentive to be on the side of the redeemers. It could create a first redeemer advantage.
“This isn’t much of an issue for funds invested in liquid equity markets, where large amounts can be sold at quoted prices at short notice.
“But for funds investing in corporate bonds and even less liquid assets, it could be.”
